If you are a homeowner, you likely have built some home equity. This can be used as collateral to borrow money. You can get a home equity loan or a home equity line of credit if you’ve paid off some of your mortgage. There are many reasons why it might make sense to borrow against your home. However, there are also some disadvantages to doing so. Consider these tips to decide whether using your home equity is right for you.
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Why might someone borrow against their home?
There are many reasons to borrow money. Using your home equity could be useful in several situations, such as:
- Making renovations on your home, which would further add to the value of your home.
- Paying for a large personal investment such as training or tuition.
- Consolidating other forms of debt with higher interest, such as credit card debt.
- Managing a large financial emergency.
You may also be thinking about using home equity to help pay your bills or give yourself some added financial flexibility. Borrowing money can be a good financial strategy, if you can manage the debt and pay it back on time.
It’s important to consider not just how much you need to borrow, but whether you can repay the loan in the required amount of time. If you can’t repay the debt on time or struggle to keep up with payments consistently, it can harm your credit score, jeopardize your home ownership, and cause more financial stress.
Consider all your options before deciding to take out any type of loan. Make sure you read the terms and conditions including how interest is calculated, when payments are due, and what could happen if you miss a payment.
What are the ways to borrow against your home equity?
Ways to borrow using your home equity, include:
- Home equity line of credit (HELOC) – a type of secured credit. The lender (your bank or credit union) uses your home as collateral on a loan, which you will then need to repay. HELOCs are revolving credit, which means you can borrow money, pay it back, and then borrow again up to a certain limit.
As with credit cards, you make minimum monthly payments on the amount you borrow. The total amount you owe will include the principal (the original amount borrowed), as well as the interest on the loan. HELOCs usually have variable interest rates which are based on the lender’s prime interest rate. The interest rate can also change. So, if interest rates rise, your minimum payment will go up. The terms of repaying the loan and the maximum credit limit will depend on the type of HELOC. It might be a stand-alone home equity line of credit, or one combined with a mortgage. - Home equity loan – a lump-sum payment, rather than a type of revolving credit. You can borrow up to 80% of your home’s value, and you will pay interest on the entire amount. You repay fixed amounts on a fixed term and schedule.
Remember that HELOCs usually have variable interest rates which are based on the lender’s prime interest rate, and that the interest rate can change. The more you borrow against your home equity, the more you’ll be affected by potentially rising interest rates. Be sure you have a repayment plan you can manage.
What are some advantages and disadvantages of borrowing against your home?
Using your home equity has some advantages and disadvantages compared to other forms of borrowing. It’s a good idea to consider the pros and cons before borrowing against your home.
| Item | Advantages | Disadvantages |
|---|---|---|
| Borrowing costs | Interest rates on home equity loans and lines of credit are lower than other types of credit, such as credit cards. | If you have a variable rate loan or line of credit, your borrowing costs will increase if interest rates go up. |
| Accessible credit | A loan secured by your home equity typically gives you access to a larger amount of money compared to unsecured loans, like credit cards. | You could be approved to borrow a more money than you need. This is risky since you’ll have to repay more than you anticipated if you borrow more. |
| Preserving and growing your home equity | If you’re using your HELOC to renovate or improve your home, it could add value to your home as an investment. | HELOCs may have flexible repayment terms such as interest-only payments, but racking up too much debt can hurt your financial health. And if you can’t keep up with your monthly payments, it could jeopardize your standing with the lender. Ultimately you could lose your home if you are unable to repay the loan. |
| Spending flexibility | You can use the money for any purpose including paying bills, renovation, investing, or supporting your business if you are self-employed. | You may be tempted to spend on more things than you need due to the wide range of options you can unlock using your home equity. |
It can be helpful to speak to a registered financial advisor to help you assess the value of borrowing against your home.
Caution
HELOCs are callable loans. Your lender, such as a bank or credit union, can ask that your HELOC be repaid in full at any time. This could happen if your property value falls significantly or if you have missed repayment deadlines.
What are some alternatives to home equity lines of credit?
There are a few alternatives to HELOCs that you may want to consider, including:
- Mortgage refinancing – This involves renegotiating your existing mortgage to access some of your home equity or to lower your interest rate.
- A second mortgage – This is a second loan you can take out on your home. The loan is secured against your home equity and the interest rate is usually higher than on first mortgages.
- A reverse mortgage is an option for people aged 55 and older. You can borrow up to a certain amount and typically, the amount is only due if the home is sold or if you die. There are also risks associated with this type of borrowing. Learn more about reverse mortgages.
Learn more about how home equity lines of credit work. Talk to your lender to confirm what type of HELOC or home equity loan is available to you.
Summary
A home equity loan or a home equity line of credit has advantages and disadvantages. You should know:
- It is a flexible way to borrow and can be used for situations, such as renovating your home or managing a large financial emergency.
- Repaying the loan requires a long-term commitment to monthly payments. If interest rates rise, the amount you owe will also increase.
- A home equity line of credit (HELOC) is a type of loan that uses your home as collateral. It is a kind of revolving credit, which means you can borrow, repay, and then borrow again.
- HELOCs are flexible ways to borrow and often have lower interest rates than other forms of credit such as credit cards.
- You can use your HELOC for different reasons, such as renovating your home, paying for tuition, or handling a large emergency.
- Repaying a HELOC requires a commitment to monthly repayments. If you’re unable to keep up with the payments, this could jeopardize your ability to keep your home.
- Alternatives to HELOCs include mortgage refinancing, a second mortgage, or a reverse mortgage.
- It is important to speak to a registered financial advisor about your financial situation before opting for an option considering both its pros and cons.
